EIU Global Forecasting Service

Major stock markets tumble, destabilising the global economy

Moderate probability, Very high impact; Risk intensity =

January 24th 2018Introduction

Global stock markets have been on a prolonged bull run, but there is still significant uncertainty over how much of this is due to quantitative easing (QE) across much of the developed world depressing interest rates and thus making stocks more attractive versus bonds.

Analysis

Although company earnings have been increasing, which would augur well for stock price increases, this is in no small part due to the ultra-cheap interest rates available for company borrowing. The global economy is likely to find out just how much the persistent rally is due to QE and low rates during the next two years as the Federal Reserve (Fed, the US central bank) gradually unwinds its QE programme and tightens monetary policy. As this takes place there is a risk that share prices could crash in the US, which would probably set off a chain reaction around the world. Although an equity slump would probably not have such severe economic consequences as the credit crisis witnessed a decade ago, it would drag down confidence and could herald recession or a notable slowing of growth in many parts of the world, similar in magnitude to that seen in the early 2000s. There are reasons not to overplay this risk, however. The Fed has been clear in its plans well in advance so that the market will not be taken by surprise. The monetary tightening that does take place will be relatively minor in the historical context. Furthermore, although the price/earnings ratio of US equities is well above historic averages, implying overvaluation, it is below the ratio at previous market crunches.

Conclusion

The US and global economies are entering uncharted terratory, and so risks are heightened.